Economic Systems


Figure 1.--Thanks to Charles Dickens and others, capitalism in the minds of many has connotations of exploitation and poverty. In reality, capitalism during the 19th created wealth. It created wealth in unprecedented quantities which enabled ordinary people to achieve decent standards of living for the first time in history. This unidentified New York immigrant family are showing off their affluence. They became affluent because in America they were able to benefit from hard work as a result of the opportunities created by free-market capitalism.

There are two basic modern economic systems, free-market capitalism and state socialism. These are of course the extremes. There are countless permutations between the two basic systems in actuality. Free market capitalism is an economic system in which the means of production are privately owned and operated. The economic goal is profit. Investments and business expansion are are determined by private decisions in the free market as opposed to the state through central economic planning. Prices are set in the open market by supply and demand. Private individuals invest in new enterprises seeking profit. Government in a capitalist system should pursue laizze faire policies. Laissez faire is a French term meaning "leave alone," meaning that the Goverment should not interfere in the operation of the free market. The mechanics of capitalism were clearly set out by the 18th century philosophes, most notably by Adam Smith in the Wealth of Nations (1776) just as capitalism was generating the indistrial revolution an reshaping Britain. Smith describes an invisible hands, meaning the self-regulating operation of the marketplace. Economics has been called the 'dismal science'. An economists can be found to support a wide range of economic systems. One of the few unrefutable economic trends is that those countries which more closely appraoch Smith free market approach are the most prosperous (America, Britain, France, Germany, and Japan) and those countries which most greatly diverge and interfere or even control the market tend to be the least prosperous (Cuba, North Korea, the Soviet Union, and Vietnam). The change in China after the introduction of capitalist economics is the most stunning confirmation of Smith economic theories. Not only are capitalist countries the most prosperous, but they are also the most creative and innovative. Liberals in the 19th century struggled to remove the heavy hand of government, mostly monarchies, from the economy. Their successes were part of the massive increase of wealth during the century. It is interesting to hear politicians talk about change and new ideas. Adam Smith clearly described how a nation can achieve prosperity and the passage of time has only confirmed that he was correct. Smith did not believe as subsequently advocated by important industrialists that there was no role for government. Smith saw the need for the government to set rules to ensure the operartion of the free market. Smith foresaw that concentrations of capital could prevent the operation of the free market. While capitalism has clerly been shown to be the most successful economic system, it is also clear that the Government is needed to establish and enforce minimum social, health, worker safety, and environmental standards. The other basic economic system is socialism. Socialism is an economic theory advocating public or common ownership and cooperative management of the means of production and allocation of resource in a society. And like capitalism, socialism had an outstanding theorist--Karl Marx. Mark publised Das Kapital about a century after Smith's ground-breaking work. Unlike Smith, very little of what Marx wrote proved to be accurate or workable. Marx explained that the driving force of capitalism was the exploitation of workers. He postulated that essential source of capitalist profits was the unpaid labor of wage laborers. He postulated that the excesses of capitalism would lead to worker revolutions in advanced industrial countries and the eventual creation of a communist society in which the state would whiter away. This of course did not occur. The communist Revolutions occurred in China and Russia, the two least advanced states in Europe and Asia. And Marx's theories proved so unworkable that Lenin/Stalin and later Mao had to rewrite the book--creating Marxist-Lennist ideology. This was a repudiation of liberalism, and the reintroduction of state controls. But the 20th century Communists wntvfar beyond the monarchial controls of the 19th century, but attempted to totally operate the economy. The results for Russia, China, and other countries attemptingthis approach was economic failure and poverty. The interesting aspect of the demobstrable success of capitalism and the failure of socialism is the number of people in the modern world who continue to embrace socialism and socialist economic theories.

Free Market Capitalism

Free market capitalism is an economic system in which the means of production are privately owned and operated. The economic goal is profit. Investments and business expansion are are determined by private decisions in the free market as opposed to the state through central economic planning. Prices are set in the open market by supply and demand. Private individuals invest in new enterprises seeking profit. Government in a capitalist system should pursue laizze faire policies. Laissez faire is a French term meaning "leave alone," meaning that the Goverment should not interfere in the operation of the free market. The Dutch invented capitalism which was appropriated by the English. It is no accident of history that those two small countries prevailed in deadly conflicts against much larger and potentially more powerful countries. The mechanics of capitalism were clearly set out by the 18th century philosophes, most notably by Adam Smith in the Wealth of Nations (1776) just as capitalism was generating the indistrial revolution which was reshaping Britain. Smith describes an invisible hands, meaning the self-regulating operation of the marketplace. Economics has been called the 'dismal science'. Some economists can be found to support virtually any economic system or polivy. One of the few unrefutable economic trends is that those countries which more closely approach Smith's free market approach are the most prosperous (America, Britain, France, Germany, and Japan) and those countries which most greatly diverge and interfere or even control the market tend to be the least prosperous (Cuba, North Korea, the Soviet Union, and Vietnam). The change in China after the introduction of capitalist economics is the most stunning confirmation of Smith's economic theories. Not only are capitalist countries the most prosperous, but they are also the most creative and innovative. Liberals in the 19th century struggled to remove the heavy hand of government, mostly monarchies, from the economy. Their successes were part of the massive increase of wealth during the century. It is interesting to hear politicians talk about change and new ideas. Adam Smith clearly described how a nation can achieve prosperity and the passage of time has only confirmed that he was correct. Smith did not believe as subsequently advocated by important industrialists that there was no role for government. Smith saw the need for the government to set rules to ensure the operartion of the free market. Smith foresaw that concentrations of capital could prevent the operation of the free market. While capitalism has clerly been shown to be the most successful economic system, it is also clear that the Government is needed to establish and enforce minimum social, health, worker safety, and environmental standards.

State Socialism

The other basic economic system is socialism. Socialism is an economic theory advocating public or common ownership and cooperative management of the means of production and allocation of resource in a society. And like capitalism, socialism had an outstanding theorist--Karl Marx. Mark publised Das Kapital about a century after Smith's ground-breaking work (1867). Unlike Smith, very little of what Marx wrote proved to be accurate or workable. Marx explained that the driving force of capitalism was the exploitation of workers. He postulated that essential source of capitalist profits was the unpaid labor of wage laborers. He postulated that the excesses of capitalism would lead to worker revolutions in advanced industrial countries and the eventual creation of a communist society in which the state would whiter away. This of course did not occur. Unlike Adam Smith who captured the nature of man, Marx's image of the future proved fanciful. The communist Revolutions occurred in China and Russia, the two least advanced states in Europe and Asia. And Marx's theories proved so unworkable that Lenin/Stalin and later Mao had to rewrite the book--creating Marxist-Lennist ideology. This was a repudiation of liberalism, and the reintroduction of state controls on a massive scale. Thus rather than new ideas, Marxist-Lenniism was in actuality a return to the failed economic approaches of the 18th century monarchies, only the levers of control were indifferent hands. It is no accident that several Communist connties revert to hereditary leadership (Korea and Romania). The 20th century Communists of course went far beyond the monarchial controls of the 19th century, but attempted to totally operate the economy. The results for Russia, China, and other countries attempting this approach was economic failure and poverty. And they required brutal totalitarian police states to operare, primarily because the Maxist idea is so divorced from the inherent nature of man. Marxist thought through the world socialist movement had a major impact on the modern world.

Permutations

There are two basic modern economic systems, free-market capitalism and state socialism. These are of course the extremes. There are countless permutations between the two basic systems in actuality. Even the most ardent supporters of free-market capitalism today do not argue that there should not be a robust social safty net. And the great propents of state socialism (the Soviet Union and China) have either disappeared or radically changed economic policy. The few remaining Communist countries have only maintained socialist policies through police state methods. An now even Cuba has begun laying off state employees because their socialist seconmy is such a failure. The economic question today is just how to mix the two basic systems. Capitalism began in Europe. Today the Western European countries are generally capitalist ecoomies with very large social welfare system. Events in the European Union have demonstrated that the Government have promised unsustainable sociial benefits. But even deeper is the fact that European social democracy have resulted in slow growth, high unemployment, and a lack of entrprenurial innovation. America has been more capitalist oriented with aeaker social welfare system. As aesult there have been higher growth rates, lower unemployment, and more innovative economic activity. The United States has been gradually moving toward the European model. The Democratic Party andespecially the Obama Administration has pushed the idea of social justice as has achieved the long time goal of achieving a national health care system. The Republican victories in the 2010 byelections has put the breaks on further movement toward the European model, setting up a fundamnental decusion Americans will have to make in 2012. While the Europeans have gradually moved toward socialist welfare systems, Asian countries have been aggressively persuong capitalism. The first successes were the Asian Tigers (Korea, Singapore, and Taiwan). The economic reforms in China and India have allowed capitalism to take root in much larger economies. The results have been spectacular. These countries have generated enormous wealth which has allowed more people to escape from poverty than ever before in human history. China raises a fundamental question about capitalism. Capitalism has developed in democratic countries. China is the first totalitarian power to introduce capitalism to a substabtial portion of the economy. Just how successful this will be in the long run remains to be seen. And will a capitalist economny undermine police state totalitarianism.

Innovation

Too often when studying economic sysrems, authors focus on income and wage levels. This is of course important. Often not given adequate attention is innovation. Where have inventions and innovations occurred? Asked yourself, what major scientific, medical, industrial innovations came from the Soviet Union or other Communist countries? The same question can be asked of the arts? The answer of course is none. Scientific, medical, and industyrial innovations have come from capitalist countries. This was true in the 19th century. And it continued to be true in the 20th century after the appearance of Communist states. All of the modern innovations that have made our modern world suchbas the transistors, computers, the internet, ect. have come from the capitalist west. Notably, many of the innovaters were immigrants to America who were able to flouish in the free market capitalist enviroment of the United States. Sergey Brin who came from Russia and hekped found Google is only the latest example. The reason for this is very simple. The seaech for profit incentives and drives innovation. State socialism by eliminating the profit motive suppresses innovation in addition to the inherent conservative tendencies of large beaureacracies. The Soviet Union is a classic example. The country seeing itself as the leasing edge of modernity put a great emphasis on science and math. They trained huge nimbers of engineers. And here we are not just talking about engineers with degrees. Soviet engineers were competent and on a technical par with Western engineers. Yet what important technolohical innovation had an impact on modern life. Incredibly none. The technical innovations of capitlism has created the affluence enjoyed in the West.

Continuing Support for Socialism

The interesting aspect of the demobstrable success of capitalism and the failure of socialism is the number of people in the modern world who continue to embrace socialism and socialist economic theories. There are several reasons for this. 1) Men like Stalin, Mao, Castro, or today Chavez who want to rule as dictators need to control the economy. And thus systems of state socialism enable them to more fully anchor their dictatorial regimes. 2) Socialism while a failed economic system, has a seductive almost religious alure. Thus socialists proclaim concepts like social justice with a moralist allure. Capitalism is a cold more austere ideological structure. Adams Smith's hidden hand makes no claims to ethics or morality, other than than a legal system should protect a person's property. While capitalism does not have the religious moral mantel of socialism, it has been proven as the system that creates wealth and stimulate economic innovation. 3) Articulate political leaders can achieve popular support by persuing populist themes aimed at redestributing wealth. Such programs are particularly effective in sicieties where wealth is not well destributed. Of course these efforts such a Juan Peron in Argentina end in failure. As Primenminister Thatcher is reported to have said, "The trouble with Socialism is that eventuakly you run out of other people's money." 4) State socialism opens emense oportunities for graft and coruption. With companies in private hands, political leaders have a more difficult job illegally getting a share of the profits. With the economy run by state corporations, it is a much easier undertaking to conduct corrupt activities. This is an especially serious problem in developing countries.

Modern Conundrum

Western countries today face a major conundrum. Socialist welfare systems and the generous benefits paid have now not only reached unsustainable levels, but are undermining the viability of the productive private sector needed to support them. Capitalism has clearly been shown as the economic system which generates wealth. All of the modern states with high living standards had capitalist economies which generated that wealth. No country has created a prosperous economy with socialism. The prosperous countries all include the countries of Western Europe, North America, and Japan, as well as the Asian Tigers. Capitalism is how these countries developed both high living standards and democratic systems. Developing countries in Africa and Asia that employed socialist policies during the de-colonization process are now mostly poorer than they were as European colonies. The attempt to associate capitalism with poverty is absurd. Capitalism generates wealth and is the source of wealth around the world. Some countries generate wealth by exporting oil and mineral resporces (Russia, Saudi Arabia, Venezuela, and other countries), but it is capitalist sectors that generate sustainable wealth around the world. Countries with economies based on state-owned enbterproses (Cuba, North Korea, and Vietnam) are without exception poor countries. Now it is true that there are two major problems associated with capitalism. First, there are variations in wealth distribution. Second there are business cycles which included periodic down turns that cause economic distress. An important note here is that government intervention in the economy has resulted in turning downturs into serious economic crises. Because of these elements of capitalism, two socialist alternatives developed--totalitarian communism and democratic socialism. All of the countries which implemented totalitarian communism (the Soviet Union, Soviet Eastern European satellites, China, North Korea, Cuba, Vietnam, and others) all with out exception had failed economies using police state methods to force their populations to live at very low levels. Another alternative has been the democratic socialism of western Europe. Gradually the Western European countries adopted a series of often costly socialist reforms like nationl health care and high benefit old age retirement systems and placeing increasing restrictions and controls on private business. Socialist politicians win elections by promising the populations higher benefits. Conservatives questioning the cost of these programs are called mean and uncaring, Britain's Primeminister Thatcher warned that 'Socialism is fine until they run out of other people's mondey to give away.' That is now coming to fruition in the European Union with countries on the perifery going bankrupt (Greece, Ireland, and Portugal) and major countries (Britain and France) having to curtail social benefits to prevent nationl bankruptsy and this is only the beginning of the crisis the EU faces. Other countries (Belgium, Italy, and Spain) have unsustainable welfare systems. The United States faces a similar problem with expanding Federal social welfare entitlements and free spending states (especially California, Illinois, Michigan, and New York) facing bankruptsy. The economic condundrum is nor only are the benefits offered and expanded public employee sector unsustainable, but they reduce the incentives to work in the productive private sector. A basic law of economics is people respond to incentives. If you pay people not to work you will get people working less. And if you tax investors more you will get less job creating investments. All this and other 'social justice' policies undermines the efficency of the private sector needed to finace all the social benefits.

Modern Economics

The two poles of modern economic life are free market capitalism and socialism. Capitalism essentially built the modern world. Invented in the Netherlands and England (17th century), capitlalism was a major factor in the industrial Revolution. Capitalism is surely why the Industrial Revolution occurred in the West and not China wjich for most of the modern era (meaning since the pas two millenia) has been more tecjnlogicall advanced than the West. There were of course other fctors such as Chinese unity compased to competing Wester nation states, but capitalism has to be one of the factors. For the first time in history, ordinary individuals in sustantial numbers were leading prosperou lives. Except in America, capitalism developed before the rise of democracy leading to a concentration of wealth. American independence began in the same year that Adam Smith published Wealth of Nations (1776). And the combination of democracy, capitlism, and a virgin comtinent created a world power out of a wildreness in a century. In Europe a prosperous middle-class emerged, but the working-class did not fully share in the bounty of capitalism. This was the genisus of socialis, Karl Marx published Das Kapital (1848). Many in Europe took to his theories as virtually a new religin. In the chaos of World War I, the first Communist state was born, combining a totalitarian political system and socialist economics. It appared precisely where Marx predicted it would not--pre-industrial Russia. And after World War II similar Communist regimes in Eastern Europe and Asia leading to the Cold War, an economic cntest between the capitalist United Sttes and the Communist Soviet Union. . In addition, the newly independent Third World adopted socialist policies which they were convinced would jump start economic development. It proved a disaster. Communism failed. When Communism and Capitalism went toe to toe (divided Germany and Korea), it was clear that capitalism was the most effective and prosperous system. In the Third World, not only did socialism fail to jump start development, but living conditions actually declined in many of the new nations. Eventually te inherent weakeness od socialis economics destroyed the Soviet Union. And Third World leaders began to see the ingerent strength of capitlism. This began with the Asian Tigers (South Korea, Singapore, and Taiwan). Eventually market reforms were adopted in China, resulting in an economic transformtion of staggering proportions. But as capitalism was brinng prosperity to the Third World at a pace never believed possible, socialism as undermining the economies of Europe. The bright hope of European unification beginning with the European Coal and Steel Community (1951) brought considerable gains in the aftermath of World War II. Europe achieved economic successes without parallel in its history. And it was widely believed that the European Union (EU) (1993) and the Euro would ensure continued prosperity. But Europe had increasingly turned to Socialist economics and by the time the contrast between the market reformsa nd the economic straight jacket of socialism was becoming increasinly apparent. This finally reached a crisis when the EU perifery began to go bankrupt (2009). The EU managed to paper over this crisis, but the unresolved problems at the perifery are now appearing at the EU core (2014). And America is not far behind. And this should not be seen as a purely economic problem. When the democracies fail with ecnomic polities, the dictators and yotalitarians are empowered.

Sources

Mark, Karl. Das Capital (1876).

Smith, Adam. The Wealth of Nations (1776).








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Created: 5:56 PM 8/11/2010
Last updated: 11:17 AM 10/19/2014